It will be interesting to see just how much “adjusting” for the coronavirus pandemic will be going on as companies start reporting their financial results for the just-ended second quarter.
The hope, as always, is for clarity. That’s a goal that gets harder to reach if executives want to try to present the numbers as if a pandemic wasn’t really happening.
Some companies have an accounting calendar that doesn’t match up perfectly with the regular calendar. As a preview of what to expect during the upcoming earnings season, consider what Apogee Enterprises Inc. last week reported from its fiscal quarter that ended in May.
It reported earnings of 11 cents per share, and “adjusted” earnings of 15 cents a share. By adjusted, it meant that it had recalculated the bottom line as if it had not spent $1.4 million or so in expenses directly related to COVID-19, the disease caused by the novel coronavirus.
In its first footnote, Apogee said the adjustment was mostly related to additional labor costs as staff had to miss work due to the virus, plus the cost of additional protective equipment for workers.
These are the costs of doing good things to meet a big challenge, of course, such as making sure the workplaces are safe. Good for them. But these are things lots of businesses have been spending money on.
Patterson Cos. and H.B. Fuller Co. also announced their latest results last week, too. And while their executives acknowledged the effects of COVID-19 on business, neither decided to present additional “adjusted” financial results to explain those effects.
Both, however, made other adjustments to get to an adjusted bottom line. H.B. Fuller all but said that “adjusted EBITDA” is its key measure of profitability.
It’s no defense of adjusting numbers for the virus to point out that investors see adjusted financial information all the time. As a measure of profitability, the kind of number presented by H.B. Fuller can even reveal more than the bottom line under Generally Accepted Accounting Principles, or GAAP.
Just to be clear, the GAAP results are always there, and there are rules about any other numbers disclosed, too. It’s certainly true that the adjusted profitability number is always bigger, as management teams add back expenses to the earnings total that might be outside of the everyday costs of operating the business.
Tweaking the profitability numbers in this way is so common that it’s even possible to sign up for seminars on how to “add back” expenses to boost the historical profitability of a business being put up for sale, to make it seem more valuable.
One of the first tasks of any serious buyer, of course, is digging into it to see if any games were played.
What H.B. Fuller used, a version of what’s called EBITDA, is enduringly popular. Sometimes called cash earnings, EBITDA is one of those terms from finance that has to be unpacked even for lots of business people.
The first part means earnings before accounting for interest and taxes, or “EBIT,” and to know whether the day-to-day business makes money, that makes some sense. The “D” and “A” refer to depreciation and amortization, which are bookkeeping measures to record some the expense for an asset used by the business for a long time.
It can make sense to add those back, too, because these capital assets likely have already been paid for even if the expense just can’t be recognized all at once.
One thing to remember when adding back depreciation, though, is that computers and other equipment become obsolete or break all the time, and new stuff will need to be purchased. Yet at least with this EBITDA calculation, flaws and all, everybody can easily figure out what’s in it.
That’s not so easy with adjustments to account for the effects of a global pandemic.
Several companies have reported an EBITDAC number in their financial results, with one of the first cases reportedly being a German manufacturing firm controlled by an American private equity investor. The “C” tacked onto the end of this adjusted profitability measure meant they also added back the financial impact related to the coronavirus.
Nobody will know what is in the adjustment for C or will really be able to judge if it captures the total effects of the coronavirus pandemic, even if management can say how much was spent on protective equipment.
Perhaps to try to nip this practice before it blossomed, the Fitch credit-rating agency pointed out in June that its analysts will be ignoring any adjustment for the COVID-19 pandemic.
“We view such measures as unreliable and open to manipulation,” Fitch added. And its arguments against this practice were all sound.
The pandemic effects are marketwide, for one thing. And it’s difficult while going through this crisis to really know whether corporate performance is being affected by something like competition.
Also, to quantify and then add back the effects of “C” suggests that whatever these effects are they are just temporary. Well, maybe. No one knows how long this crisis will last or how much different the world will be, including the purchasing habits of customers, after the pandemic finally subsides.
Then there is the impact of good surprises, and H.B. Fuller CEO Jim Owens described one last week for investors and analysts on a conference call. H.B. Fuller, he said, had just repurposed a kind of disinfectant usually used in cases of water damage and started selling it to kill the novel coronavirus.
Looking ahead to when the big slug of companies start reporting their quarterly results, it’ll be as important as ever to hear from senior managers what’s happening in their business, the good and the bad. Investors will still need to know what they plan to do.
But please, let the numbers speak for themselves.